Monday, August 26, 2013

Hit 'Em Where It Hurts

When people misbehave — badly enough — they go to jail. But when corporations misbehave, they can't go to jail. So they pay fines instead. Recent years have brought a wave of enforcement actions for various corporate offenses, from banks ripping off customers, to investment managers trading on inside information, to drug companies poisoning patients, to energy producers polluting public waters.  
Corporations usually find a little bit of silver lining in those monster settlements. They get to deduct the payments on their taxes! You like that? You and I get to help pay the freight for their cheating!
Now, Section 162(f) of the Internal Revenue Code states that "no deduction shall be allowed . . . for any fine or similar penalty paid to a government for the violation of any law." But defining a "fine or penalty" isn't as obvious as you might think (and it gives corporate tax lawyers the chance to bill a lot of hours arguing about it). Few of those settlements, especially in the Wall Street arena, require offenders to admit wrongdoing, and most include some form of restitution or disgorgement of profit. Those amounts aren't considered a fine or penalty, so they remain deductible.  
What does that mean for our friends at the IRS? Well, when Exxon-Mobil paid $1.1 billion to settle claims over an oil spill in Alaska, it actually cost them just $524 million after tax. When Bank of America agreed to pay $335 million to settle charges that they had discriminated against Black and Hispanic borrowers, they got back up to $117 million of it in tax savings. Similarly, when credit card giant Capital One paid $210 million to resolve charges that they had duped customers into paying for credit monitoring and other add-on services, they saved millions in tax.  
But now it looks like Uncle Sam is getting fed up with subsidizing the settlements by cutting off those juicy tax breaks. Now he's working to hit 'em where it really hurts!
  • Back in November, oil producer BP agreed to pay $4 billion to settle the Deepwater Horizon spill. Ordinarily, that might have meant a fat tax deduction to cushion the blow. But no such luck this time — the settlement included language explicitly defining the damages as "punitive," which prohibits BP from deducting any of that amount from their U.S. taxes.
  • Earlier this month, Swiss bank UBS paid $500 million to settle charges they manipulated the "LIBOR" interest-rate benchmark. Again, that settlement prevents UBS from deducting the penalty on their taxes.

  • Most recently, hedge fund manager Philip Falcone agreed to admit wrongdoing, accept a five-year ban from the securities industry, and pay an $18 million nondeductible penalty. Denying a tax deduction seems especially appropriate in Falcone's case, since federal regulators said his actions "read like the final exam in a graduate school course in how to operate a hedge fund unlawfully."
Tax policy questions like these can sometimes sound boring and pointless. But this one has real consequences. On the one hand, some experts argue that letting miscreants deduct settlements on their taxes encourages companies to settle out of court and avoids ongoing litigation. On the other hand, consumer advocates respond that tax-deductible settlements are a slap in the face to taxpayers, who wind up footing 35% of the tab.

What do you think? Do the tax deductions still serve a legitimate purpose? Or should Washington keep up the new hard line?

Tuesday, August 20, 2013

Are You Sitting Down?

Let's start by saying that no one likes getting audited. But the average income tax audit isn't the end of the world. For tax year 2012, the IRS audited just 1,481,966 returns out of over 143 million filed, or barely one in a hundred. And according to the IRS Databook, the average "deficiency notice" demanding more tax was just $10,331. That's nobody's idea of a party, of course. But it shouldn't bankrupt anyone who makes enough to owe that much extra tax.  
Things are a little different when it comes to estate taxes. For starters, the tax applies to the value of your assets, not the income they produce. It doesn't kick in until your taxable estate after all deductions tops $5.25 million ($10.5 million per couple). But the tax itself is 40%, which is higher than the top income tax rate. With so much more at stake, the estate-tax audit percentage is naturally far higher than the percentage for income tax — for 2012, the IRS audited 3,762 out of 12,582 estate tax returns filed, or nearly one in three. As for the average deficiency, well, here's hoping you're sitting down — it's a whopping $305,529!  
Of course, that's just the average. Half of those 3,762 deficiency notices are mercifully lower. And half of them are higher — some far, far higher.  
Which brings us to William Davidson. A Detroit native, Davidson grew Guardian Industries onto one of the world's top manufacturers of architectural glass, automotive, and building products. He also owned the NBA's Detroit Pistons, the WNBA's Detroit Shock, and the NHL's Tampa Bay Lightning. Davidson died on March 13, 2009, at age 86, with a net worth estimated at $5.5 billion.  
Now, Davidson didn't make his fortune by being stupid. As a former attorney, he knew the IRS would take a close look at his estate-tax return. He and his lawyers took careful steps to protect his heirs from the worst of the tax. So you can only imagine their surprise in May, when the IRS sent them a bill for 2.8 billion dollars!  
Davidson's case involves three main issues. First, how much was the privately-held stock worth, which he transferred into trusts for his children and grandchildren? The IRS says Davidson undervalued it by as much as $1,500 per share. Davidson's lawyers say that automotive and construction stocks were tanking in late 2008 and 2009, and it was entirely foreseeable at that time that the company's sales and profits would plunge. Second, how much should the trusts have paid for the stock? Davidson used a "self-canceling installment note," or SCIN, which meant the trusts would make payments to Davidson for that stock while he lived, but the debt would expire at Davidson's death. The IRS has no problem with the SCIN strategy itself, but says the payments should have been higher based on Davidson's life expectancy when he made the transfer. And third, they argue, Davidson owes extra tax on gifts he made to his family as far back as 2005.  
Needless to say, Davidson's lawyers aren't taking the $2.8 billion bill lying down. Last week, they filed a petition in U.S. Tax Court telling the IRS to take a hike. Experts say that the strategies he used aren't the issue — it's the scale that makes the case so juicy. But it's one of the biggest estate-tax fights ever, so we can probably expect a long and difficult battle.  
We realize you don't have $2.8 billion for the IRS to claim. But that doesn't make you any less important. Proper planning is the key to making the most of your legacy too, no matter how much you have to leave. So call us with your questions. And take at least a little comfort in knowing that the IRS gets to audit your estate tax return only once!

Tuesday, August 13, 2013

Sentencing Reform

Back in 2007, a Los Angeles judge sentenced actress Lindsay Lohan to one day in jail for misdemeanor drunk driving and cocaine charges. California's prisons are notoriously crowded, so Lohan walked out of the joint after just 84 grueling minutes. She didn't even have time to change into an orange jumpsuit. Lohan's "sentence" drew headlines as an example of lax justice. But now comes news that a judge has sentenced a 79-year-old widow to less than one minute of probation — for tax evasion, no less. Can the punishment possibly suit the crime?
First, a little background. The Justice Department has made cracking down on secret foreign bank accounts a top priority. Those efforts got a huge boost when Bradley Birkenfeld, a banker for Zurich-based UBS, blew the whistle on the bank's efforts to help U.S. depositors avoid tax on their accounts. UBS settled the case by paying a record 780 million dollar fine and turning over information on nearly 5,000 U.S. depositors.
Around that same time, the IRS offered an amnesty program for taxpayers who had concealed their accounts to avoid prosecution by 'fessing up, paying back taxes and fines, and fingering the advisors who helped them hide their assets from the government. Since then, over 38,000 taxpayers have entered the program, paying $5.5 billion and pledging $5 billion more to make good.
Now, back to our story. In 2000, money manager Mortimer Curran died in Palm Beach. Curran left his wife Mary an account at UBS, which he himself had inherited from an aunt in Monte Carlo. Mary, who has no college education and hasn't worked outside the home in over 50 years, took the bank's advice and left the money in the account. She continued to live modestly in the same house with green and white Formica counter tops that she and Mortimer had bought in 1982. (OK, next door to Bernard Madoff — but still, green and white Formica counter tops.) And she devoted most of her time to volunteer work on behalf of the Opportunity Inc. Early Childhood Center and the Rehabilitation Center for Children and Adults.
In 2009, after the account had grown to $43 million, she contacted a lawyer. Together, they decided to report her account. Unfortunately, he didn't file the disclosure paperwork until three weeks after UBS had "ratted her out" as part of its own settlement. That meant she couldn't join the program. Uh oh.
Last November, the Justice Department indicted Mrs. Curran. In January, she pled guilty to two counts of tax evasion, paying $667,700 in back tax and a $26.6 million civil penalty. And on April 13, Curran appeared before U.S. District Court Judge Kenneth Ryskamp for sentencing. She still faced up to 37 months for the crimes she had admitted. Would she serve hard time? Get a jailhouse tattoo? Maybe join a prison gang?
No, no, and, thank goodness, no. Ryskamp sentenced the "unsophisticated" Curran to a year of probation — then immediately revoked it. He said "this really is a tragic situation," and "the government should have used a little more discretion." He even urged Curran's attorney to seek a presidential pardon for his client — then told the prosecutors it would be "spiteful" for them to oppose it!
Mary Curran's five seconds of probation may seem like the lightest possible slap on the wrist. But that $26 million penalty hurts. Too bad the Currans didn't understand that they didn't have to risk so much to pay less tax. They just needed a better plan. If you're ready to pay less tax — without risking even five seconds of probation to do it — call us for the plan that helps you do just that!

Tuesday, August 6, 2013

Can You Keep A Secret?

Benjamin Franklin famously said that "three may keep a secret, if two of them are dead." And that was before the National Security Agency and other government agencies could track your phone calls, browsing history and even your driving habits. Keeping secrets is especially hard in politics — just ask Carlos Danger or Client Number Nine! But now a couple of Senators think they've found a way to rewrite the entire tax code behind closed doors. What could possibly go wrong?  
Senate Finance Committee chair Max Baucus (D-MT) wants to pass a tax reform bill before he leaves office at the end of next year. He and ranking minority member Orrin Hatch (R-UT) recognize that the actual rate you pay doesn't matter much if you use special preferences and loopholes to avoid reporting taxable income in the first place. So they've boldly decided to start with a "blank slate," wiping out a trillion dollars' worth of deductions, credits, loopholes, and strategies off the books.  Then their colleagues can propose adding back goodies like tax-free health benefits, education credits, and tax-deductible charitable contributions and justify why they belong in the new Code.
Sounds great in theory, right?  The problem, of course, is that tax reform is an intensely political process. K Street lobbyists circle Washington like Predator drones, waiting to fire on any member who dares challenge their clients' pet interests. Any senator who proposes dropping the mortgage-interest deduction, for example, guarantees immediate fire from any group that benefits from home ownership. (This includes obvious constituencies like banks, builders, and real estate agents, but also less-obvious folks like Home Depot, Martha Stewart, and Bob Vila).  So, Baucus and Hatch came up with a plan to cover their colleagues' vulnerable rear ends from the inevitable backlash. How likely do you think it is to work?
  • They'll start by giving each Senator's written proposal a unique identifying number, a confidential seal, and a special encryption. Then they'll archive the files on a special password-protected server and keep paper copies in locked safes. (Of course, there's no guarantee that hackers won't come along and leak the files all over the Internet.)
  • Only Senators Baucus and Hatch, along with 10 handpicked staffers, can get their curious little fingers on the proposals. (If Ben Franklin didn't think three could keep a secret, what do you think he would make of a dozen? Might as well just splash the proposals on the front page of Politico! And what happens when those 10 staffers inevitably leave "the Hill" for well-paid lobbying gigs of their own?)  
  • The National Archive will keep the proposals under seal until December 31, 2064. (The goal, obviously, is to protect them until all of the current members have left office. But with Senators serving longer and longer terms, there's no guarantee it will happen. South Carolina's Strom Thurmond took office shortly after the Civil War and served until long after his hair had turned the color of Tang.)
  • Finally, Harry Potter will cover each proposal with an invisibility cloak until He-Who-Must-Not-Be-Named is defeated. (OK, we admit we just made that one up. But it's about the only idea with any chance of success.)
Here at our office, we understand the real secret to paying less tax isn't a secret at all — it's proactive tax planning. That's why we don't just settle for helping you record history — we help you write it, with a complete menu of court-tested, IRS-approved strategies. Come to us for a plan, and you won't need to wait for Congress to act!